Email of the day (2)
Comment of the Day

August 26 2011

Commentary by Eoin Treacy

Email of the day (2)

on China, Australia and commodity demand:
"I refer to the Rare Earths article in Comment of the Day. Part of China's new 5 Year plan; which I am unsure when it starts 2012 or 2013 - (as a China watcher you would know which year). There is the goal and ambition to transform the Chinese economy up the value chain in particular in new technologies. Beijing have watched what Japan has so successfully achieved in this area and set very ambitious goals to follow the Japanese example.

"How do you create the incentive to start these new technology industries? Well PM Wen Jiabao's Rare Earth policy would seem to be very successful at getting Western companies to bring to China their knowledge and skills in high tech industries that require Rare Earths. This is providing the catalysts to start these new industries in China. It has been reported to me Microsoft's 2nd largest office is in China working on software engineering and design.

"In the West we can mistakenly see China as the sweat shop making sports shoes and clothing for the world. These are low value add industries that China has little competitive advantage other than price. It must be remembered that China's higher education system produces vast numbers of University Graduates every year. Speaking personally with some of these graduates they reported to me they find it very difficult to secure suitable career opportunities that would satisfy their academic qualifications.

"From an Australian perspective we need to be cautious that China's commodity demand could easily peak much sooner than many have forecast. Since I live in a country where long term planning is about 6 weeks you have to admire Beijing's efforts to transform the Chinese economy into the knowledge economy. These new technology industries will significantly raise the living standards and lifestyle choices of an ever growing Chinese middle class. History has shown that all commodity booms come to a nasty end. Unfortunately my country is poorly preparing for when the current commodity boom ends.

"I am continually told that statically China's cannot have a very large middle class. This comment I find a little amusing in that we see an ever growing number of Chinese taking overseas holidays. To my mind these Chinese travellers are very much a sign of a growing Chinese middle class enjoying the rewards that middle classes in the West also aspire to. As you have reminded me all Chinese statistics are very questionable. I would suggest even if it's for national statistical purposes I think most Chinese would be very reluctant to tell Beijing how much they earn.

"Thank you for all your good work and continued excellent market insights."

Eoin Treacy's view Thank you for this illuminating email and you kind words. For your reference the 12th 5-year plan is from 2011 to 2015. The next Chinese Presidential election will occur in 2012. I did not know that Microsoft's second largest office was in China. I thought I had heard somewhere it is in India but either way the point remains valid that China is rapidly moving up the value chain in terms of manufacturing. I agree it would be a mistake to think that China is merely a sweat shop for low margin, low cost goods. Chinese wages have been rising quickly and many of the lowest margin manufacturing businesses have already migrated to cheaper jurisdictions in emerging Asia and even parts of Africa.

Anyone arguing that the Chinese middle class cannot expand has clearly never been to China, looked at automobile sales figures, the purchasers of high end property globally, who is driving demand for luxury goods, the patrons of golf courses across Asia or fashion outlet stores in Italy and France. The increased spending power of the emerging middle class is not a trifling matter. Chinese official statistics need to be viewed with a degree of analytic scepticism but this does not hide the fact that an increasing number of Chinese people are wealthy by any measure and are having a marked effect on the balance sheets of major globally oriented consumer companies.

I agree all commodity bull markets eventually end badly for commodity producers. Supply always eventually overcomes demand because new entrants compete by expanding capacity and established businesses have no choice but to do the same. However, while per capita consumption of key commodities has risen considerably in China and other leading growth markets, it is still well below that of major industrialised nations. This is the first time in history that billions of people have been lifted out of poverty in such a short period of time. The process is far from over. The commodity bull-run of the 1970s ran for a decade. Secular bull markets in commodities have been known to last for considerably longer.

Iron-ore and coal are by far the most important Australian exports to China. This exposes the Australian economy to the health or otherwise of the Chinese steel sector. On our trip to China last year, Mrs. Treacy's former colleague, the current CEO of ThyssenKrupp in Shanghai, described to me how oversupply is a major factor in the Chinese steel sector. That is not a situation that can go on in perpetuity. Therefore iron-ore and coking coal demand data should be useful for those monitoring the Australian economy. Shares such as BHP Billiton, Rio Tinto and Fortescue Metals should be a useful barometer.

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